Two Economist Reports on FIE Law in China

Business in China

Mixed messages

A missed opportunity to improve the environment for foreign companies in China

LI KEQIANG, China’s prime minister, made a big promise to the world’s leading businessmen at the World Economic Forum’s annual gathering in Davos in January 2015. It was that China would introduce a new legal regime for foreign investment that would “treat Chinese and foreign companies as equals”. Its government has duly unveiled a set of revisions to its foreign-investment laws that come into force on October 1st. The standing committee of the National People’s Congress adopted the laws earlier this month and bureaucrats have drafted detailed rules.

The revisions, and the extent to which they fulfil Mr Li’s grand pledge, are an important indicator of how serious the government is about pursuing other initiatives to liberalise rules on foreign investment. China is currently negotiating a bilateral investment treaty (BIT) with the United States. American businesses hope it will lead to greater market access. A BIT with Europe is scheduled to follow.

How, then, do the changes measure up? On the face of it, they involve a welcome shift away from the current regime, which obliges foreign firms to win numerous approvals and is both burdensome and often influenced by domestic politics. The new framework pursues efficiency. Instead of demanding approvals, it seeks to usher in a simpler, registration-based system. Whereas the current approach is based on a long list of strategic industries in which foreign investment is either restricted or off-limits, the overhaul promises to replace it with a relatively short “negative list” of forbidden investments in areas such as defence and media. According to some, such as Hogan Lovells, a law firm, the reforms herald a sea-change in China’s foreign direct investment (FDI) regime.

Yet the revisions leave intact much that is wrong. China has kept a complex set of rules restricting inflows for decades. As well as the long-standing practice of deeming many industries strategic, the government still requires foreign firms to form joint ventures with Chinese companies and to hand over intellectual property via technology transfers. Repatriation of profits is tightly controlled. And because the approvals-based approach is likely to persist, despite official promises, every foreign investment is subject to the vagaries and corruption that comes with a one-party, highly bureaucratic state.

Most glaringly, there is nothing in the new changes that genuinely places foreign firms on an equal legal footing with local ones. The EU Chamber of Commerce in China dismissed the new reforms as “not bold enough”. It issued a thinly veiled warning that the EU may make it harder for Chinese to invest in Europe.

Another big omission is the government’s failure to tackle the problem of offshore legal structures known as variable interest entities (VIEs). Foreign investment is banned in Chinese internet companies, but by getting foreigners to put money into VIEs to which the Chinese firm promises to pay dividends, many firms have got around this ban. A proper reform would have ended the ambiguity surrounding these vehicles. It was not forthcoming.

The tape is red

There are already signs of bureaucratic resistance even to the government’s modest revisions. It is questionable, for example, whether officials will accept the shift from an approvals-based scheme to a registration system. Bureaucrats at the top economic planning agency, the National Development and Reform Commission, are said to reject the idea that the approvals-based system is coming to an end. They say the new rules are just a modification of the existing approach to foreign investment.

Meanwhile, multinationals are no longer clamouring to put money into China’s slowing economy. FDI has been flooding into the Middle Kingdom for two decades. Inbound direct investment reached a peak of nearly $300 billion in 2013 but has cooled off since. Foreign inflows are slowing just as Chinese outward investments are skyrocketing (see chart). It seems exactly the right moment to roll out the welcome mat, but the changes going into effect fall well short of what multinationals had hoped for. As Jake Parker of the US China Business Council, a lobby group for big American firms, points out, Chinese leaders have talked about lots of reforms but “the lack of implementation has created uncertainty about the policy direction and undermined confidence.”

Foreign firms in China

You’re still welcome

The country’s leaders seek to reassure nervous foreign businesses

THE bosses of foreign firms with operations in China grumble that their lives have got harder of late. China used to be a frontier market offering endless double-digit growth. Officials put out the welcome mat, and were open to wining and dining. Regulators were no more bothersome than in other emerging markets.

Now, growth is slowing: official data released this week confirm that the economy grew by 7.4% last year, the slowest rate in 24 years. A crackdown on official corruption has made it impossible to win friends in government. And antitrust authorities have taken a tough line with foreign carmakers, drugmakers and other firms that had hoped their guanxi (connections) offered them protection. Many foreign bosses are now convinced that the golden age for multinationals in China is over.

That may explain the charm offensive the government launched this week. The prime minister, Li Keqiang, led a delegation of Chinese worthies to the World Economic Forum’s meeting in Davos, Switzerland. He promised the assembled global business elite his country would “treat Chinese and foreign companies as equals” and “rigorously reject protectionism”.

Ahead of his speech the government unveiled a dramatic proposal to ease its restrictions on foreign investment. Over the past two decades, China has maintained a highly restrictive, complex set of rules on how foreigners can invest on the mainland. In the many industries deemed “strategic”, for example, they must invest only through a joint venture and must transfer technology to the local partner. Flows of funds in and out of the country are also tightly controlled.

The draft reforms, which are now open for comment, include scrapping almost all of these cumbersome controls. Foreign firms would supposedly be treated the same way as national ones. The clunky system of case-by-case approvals will be replaced by a simpler “negative list”: if your industry is not on it, you do not need permission to invest. Daniel Roules of the Shanghai office of Squire Patton Boggs, an American law firm, believes the new law—if and when it comes into force—could usher in a significant and welcome change in the climate for foreign firms.

Mr Li is also pushing for bilateral investment treaties with the United States and the European Union, which could further reassure foreign investors worried about putting more money into China. His boss, Xi Jinping, agreed a sweeping free-trade agreement with Australia on the heels of the recent G20 summit in Brisbane. This provisional deal, which must now be ratified, goes much further than previous accords in opening up China’s service industries to foreign investment.

Taken together, say optimists, there could yet be another golden age for foreign direct investment (FDI) into China. A recent report by King & Wood Mallesons, China’s biggest law firm, forecasts that FDI could reach $188 billion in 2020, up from about $120 billion last year.

Nevertheless, foreign businesspeople should not break out the champagne yet. The proposed reforms are a strong signal that foreign money will continue to be welcome in China. However, they may do nothing to help foreign-owned firms compete on equal terms with politically well-connected domestic ones, to end the subsidies lavished on state-backed enterprises, or to rein in regulators keen on bashing outsiders. The areas of business most tempting for foreigners, such as finance and the internet, will still have restrictions on foreign ownership. If China’s leaders were to take on all these distortions, then they would get a far warmer round of applause at their next Davos appearance.